Beware these stock funds for big capital gains distributions this year. How to manage the tax bill
A year-end surprise is coming for mutual fund investors: Actively managed funds are poised to distribute capital gains, some of them enormous, to shareholders. October volatility notwithstanding, the S & P 500 is heading for its fourth consecutive year of double-digit gains; it’s up more than 10% year to date. “We’ve seen some strong gains in the market, specifically around the artificial intelligence trade,” said Morningstar senior manager research analyst Stephen Welch. He recently compiled the firm’s list of funds with the highest estimated distributions for 2026. “We had strong markets in the past several years, so mostly these funds are sitting on unrealized capital gains,” Welch added. Fund families are rolling out estimates for their capital gains distributions, which will transfer to shareholders in December. The distributions could be hefty, depending on several factors. Consider the Nationwide Renaissance Small Cap Growth Fund (NWGPX) , which is heading for an estimated distribution of 56.6% of its net asset value. The A-share version of the MFS Global Equity Fund (MWEFX) is set for a distribution in a range of 31% to 33% of NAV. The culprit Capital gains distributions can be unexpected for investors, who are left on the the hook for taxes even if they don’t sell any shares. “I think of it as the Christmas surprise, between Thanksgiving and Christmas, if you’re not paying attention to it, you get this big long-term capital gain, and if your planner isn’t paying attention to it, it can throw a wrench into your tax projections,” said Brian Kearns, founder of Haddam Road Tax & Consulting in Evanston, Illinois. Affected investors are holding these funds in their taxable brokerage accounts. The IRS deems the distributions to be long-term capital gains, regardless of how long an investor has held the fund. That means the distribution is subject to a rate of 0%, 15% or 20%, depending on your taxable income. You won’t be affected if you hold the fund in a tax-deferred account, like an individual retirement account or a 401(k). Funds push out capital gains for several reasons. First, if a fund experiences significant outflows, the fund manager needs to sell appreciated securities to cash out departing shareholders. “This has been another year of a similar story of flows coming out of traditional mutual funds and going to ETFs, more passive-oriented options,” said Welch. Strong performances in technology and emerging markets have also resulted in significant returns for those funds, he added, another driver of big distributions. Finally, one-off manager changes or updates to investment strategies can result in major distributions, Welch said. The tax bill The good news about the heads up on the distribution is that investors still have some time to prepare for it. For starters, tax-loss harvesting involves selling losing holdings and using those realized losses to offset capital gains elsewhere in the portfolio. If losses exceed capital gains, you can apply up to $3,000 of the loss against ordinary income. Any unused loss can be carried forward into future years. Resist selling funds that have a habit of churning out capital gains distributions: You’ll end up on the hook for the appreciation you’ve had since you’ve held the fund. “If you’ve owned the fund for five, 10, 15 years, you might be sitting on a large gain yourself,” said Jeff DeMaso, editor and founder of The Independent Vanguard Adviser. “You wouldn’t sell a position you’re up 100% in to offset your capital gains.” Have your capital gains distributions go to cash, rather than having them reinvested into the fund, he said. “You can use the distribution to help rebalance the portfolio. You can also start directing some cash to maybe a more tax-friendly fund, an index fund or an ETF.” “You’ll still have your existing shares and you might face more capital gains distributions next year, but it starts to nudge the portfolio to a more tax-friendly stance,” said DeMaso.
